MagicDiligence (< 20)

Ebix: Growth, Value, and Serious Allegations

2

Ebix (EBIX) is a recent addition to the Magic Formula® screens. The company sells software and e-commerce systems to the insurance industry. There are 4 product/service groups.

The Exchanges unit contributed 80% of 2012 revenue, up 22% from 2011. Ebix operates insurance exchanges in the life insurance, annuity, health benefits, workers compensation, and property/casualty (P&C) areas. An exchange is basically a marketplace where clients can compare plans and apply for coverage. Ebix earns revenue from insurance providers that pay monthly subscription fees to list their products, and transaction fees for each transaction processed on their exchanges. Additionally, providers may contract Ebix to build custom interfaces from their systems to the exchanges.

Broker Systems was 9% of revenue, up 3%. This business consists of developing and deploying "back-end" systems for P&C brokers in the U.S., Australia, and elsewhere. Business Process Outsourcing (8%, +8%) creates and tracks certificates of insurance for clients in the U.S. and Australia. Lastly, Carrier Systems (2%, -8%) develops custom systems for P&C providers.

Going strictly by the numbers, Ebix looks like an attractive investment. 5-year compound annual revenue growth rate is 22%, and operating margins have remained very stable around 40%. While debt on the balance sheet does outpace cash ($82 million vs. $37 million), Ebix generates substantial free cash flow, around $70 million each of the past 2 years and growing at a good rate. This allows the firm to execute share repurchases (shares declined 4.5% last year), and pay a decent and safe-looking dividend (1.9% yield at just 10% of free cash flow).

Electronic insurance exchanges have a good growth outlook going forward. The long trend away from paper and towards electronic and online exchanges has been developing for many years. Efficiency is a key differentiator in the industry, where low costs are critical to success. "Obamacare" set the stage for a potentially major uptick in demand for health insurance exchanges, although whether this develops is yet to be seen. Most of Ebix's growth has come from acquisition to expand into new geographies and new lines of products - I see this continuing more or less unabated.

Finally, the stock price seems right. At under $16, Ebix sells 40% below its 52-week high, and at a P/E ratio of just 8.6 - hardly appropriate for a growth company.

So what gives here? Well, it doesn't take much digging to see that Ebix has an alarmingly high short ratio of over 41%, meaning a huge amount of investors are betting the stock price falls even farther. But why?

The latest big drop in the stock price came in late February, when this report on Seeking Alpha drove it down 27% in one day! This followed a 14% drop in early November after Bloomberg said the SEC was investigating accounting practices at the firm - a charge vehemently denied by both management and the company's law firm.

I read over the SA article, which is alleging accounting improprieties. Specifically, it questions the handling of a $70 million loan in Ebix's foreign subsidiaries, while also citing comments from former officers of the firm alleging questionable practices. As far as the SEC probe goes, I can find no new news on it since November and management has not mentioned it in their conference calls or press releases. At this point, it seems like Bloomberg may have been wrong, and it wouldn't be the first time.

All that said, it still feels like there is just too much odor from this stock to consider recommending it. What is absolutely true is that Ebix files a lot of amended quarterly (7 in last 2 years) and annual (5 in the last several months!) SEC reports. But more than anything, Ebix is simply a good ole fashioned battleground stock. And you know what happens when innocents stumble onto a battlefield...

For the brave and intrigued, my quantitative valuation on Ebix is about $26 per share. That's 68% upside from current levels, which may be enough for some folks to take a flyer. But I've seen too many investors get burned by battleground stocks (myself included) to consider recommending this as a Top Buy pick.